An American Perspective from China

Am I a China Bear?

There are two schools of thought on the Chinese economy right now. The first says “It’s always darkest just before the dawn.” The second says “It’s always darkest just before it goes pitch black.” It’s clear that China’s economy is slowing. But what happens next is far from clear, and the subject of much debate.

The conventional wisdom at the moment, among officials and economists, runs something like this: China’s economy is slowing alright, perhaps a bit too much for comfort, but it’s mainly a self-induced slowdown driven by the government’s own cooling measures. GDP growth is still above Premier Wen’s target of 7.5%, and is destined to improve in the 2nd half of the year as the government switches gears to re-stimulate the economy. The slowing inflation rate gives them plenty of room to ease. The real estate market has already bottomed out, and the banking system is stable. Maybe stimulating more investment isn’t the best thing for China’s economy in the long run, but Chinese leaders have the ability to kick that can down the road for some time. They have time.

No they don’t. I disagree with virtually every single element of the conventional view I’ve just outlined. Over the next few days, in a series of posts — on credit, real estate, inflation, and stimulus — I will describe how and why. For the last two weeks, I’ve been on a bit of a hiatus from this blog, focusing on my Twitter feed @prchovanec — which if you haven’t checked out, you should. Not only has Twitter been a wonderful way to introduce new readers to this blog, it has offered me an excellent perch for monitoring the data and news stream coming out of China, while trying to make sense of what it all means. Several important story lines have emerged, and what I’m seeing really worries me.

Indeed I am worried — not thrilled, not vindicated — because contrary to stereotypes, I do not consider myself a “bear” on China. In that respect, I would like to make a few points. Because over the next few days I’m going to be saying some very negative, critical, and even scary things about China’s economy, these points are quite important.

1) I don’t hate China. I’m not “rooting” for China to “crash and burn.” I realize that at least a few of my Chinese readers, when they hear me harshly criticize policy or make dire warnings, might conclude that — as an American — I’ve caught an acute case of China-envy and would love nothing better than to see China taken down a notch. In fact, I am so critical not because I want the worst to happen, or believe it must happen, but because I hope and believe the worst can be avoided, if clear-sighted, courageous choices are made. My wife is from Beijing, my son was born here, and we are all tied by blood and affection to a whole host of relatives in China whose struggles and aspirations we share. On a less personal level, no matter what you think about China’s current form of government, or the implications of its rising global influence, the complex challenges and opportunities posed by a strong and prosperous China are infinitely preferable to the terrible dangers and uncertainties the world would face if China were to “collapse” or just lose its way in confusion.

2) I’m not a “Perma-Bear”. In other words, I’m not the kind of commentator who has been warning of China’s imminent crash for so long that eventually I’m bound to get it right, like the broken clock that tells the right time twice a day. I’ve been traveling to China for 26 years, and living here for over a decade. For most of that time, I would have described myself as a China “bull.” I’ve seen an incredible transformation of an economy, an astonishing burst of wealth creation. I’ve worked for private equity funds that invested in promising Chinese companies and helped them grow. In the past, the problems — bad debt, inefficient state industries, protected markets — were outweighed by even more positive developments: the wholesale privatization of small and medium state enterprises, China joining WTO and committing to more open markets, foreign investors taking an active stake in reforming state-run banks. But something changed in the past few years, when China adopted state-managed stimulus and money-printing as a model for permanently boosting economic growth. I don’t see myself as inherently a “bull” or a “bear” on China. The fact is, I see plenty of promising areas where China can achieve huge productivity gains and realize meaningful growth — but I don’t see that happening as long as China keeps trying to insulate favored market sectors from economic reality.

3) I’m not “talking my own book”. Earlier this week, former Morgan Stanley strategist Stephen Roach warned CNBC viewers to ignore skeptical concerns about China’s economy. “Beware of people who say things like this,” he told the anchor, “Oftentimes they’re just talking their own book.” In other words, they’re talking down the Chinese economy because they have taken short positions that will pay off if it tanks, or merely if market sentiment turns negative enough. I don’t know about other people, but I can assure you that when I express concern about the Chinese economy, I am NOT talking my own book. I own (one) property in Beijing, which we bought at a reasonable price. My wife’s career, with a global investment bank, rides on the health of the China market. Virtually all of our income is in RMB, and there are barriers to moving it out of the country. Because of my wife’s job, we are prohibited from taking any short positions in the market, at least actively — in fact, it’s very hard for us to move in or out of any China-related investment freely. In our lives, careers, savings, and income, we are exposed long on China — and like most people in China, can’t really do much about it. But I’m still going to call things as I see them, when I see them heading for a cliff.

In short, I have no reason for talking down China, and plenty of reasons for wanting China to get things right. Keep that in mind as you read my “bearish” Tweets, or consider my negative outlook for China’s property market or my skepticism towards China’s renewed stimulus efforts. I would much prefer to see a very different fact pattern and reach far different conclusions.

just a joke on this: when you said you did not talk your own book. it depends…if you care about your life wealth in present value, may be you should say as bad as possible. this is a way to hedge yourself. if you turn out to be right, you lost your current long position, but gain the reputation, which will be positive for your future income…

Perhaps you love China so much that you want your voice/concerns to be heard by the Chinese authorities therefore you deliberately painted an extremely bleak, pitch black picture? 🙂

Reading what you have been tweeting already, one gets the idea that the Chinese economy is already in the process of imploding, collapsing, “going pitch black”, whatever you’d like to call it and it has reached the point of no return. How can the messages be any more critical, negative and scarier than what we have already seen? I can’t think of anything short of predicting the downfall of China will do it.

Patrick, I don’t doubt for a second that you are simply speaking your own mind and there are no evil agenda or ulterior motives (like “talking about your own book”). However, I do find your messages share the similarities with western reporting on China in general, that is, completely focusing on the negative stuff (not necessarily untrue) and completely ignoring the positive stuff (as if there weren’t any). I think it was Nicholas Kristof who said something to the effect of “If there were ten planes taking off and one plane crashing, western journalists will only report on the crash and ignore the ten planes taking off”, something like that. My problem with this western narrative/school of thought is that it does not paint a complete but a biased picture. And maybe it is just me, sometimes I felt your underlying messages were more than just being negative and critical, to the point borderline cynical; therefore it is not hard to see where you stand vis-a-vis not just the Chinese economy, but everything Chinese in general.

I sincerely hope your fears are overblown and you are wrong. That said, 忠言逆耳利于行。, I certainly hope the Chinese authorities are reading your messages and act accordingly. Instead of predicting the end of China as we know it, perhaps you should tell them what you think the necessary corrective actions that need to be taken are?

@ juchechosunmanse
Your comments about negativism are fair. However, look at the other side. Patrick and michael Pettis are analysts who try to understand what is really going on. Meanwhile, the CCP surpresses info, denies reality, intimidates people from asking the right questions and generally puts forth a superficial explanation of how China performs. Are you not the least bit suspicious when things just don’t add up?
The principle defense i hear against objective criticism is the laowai are just trying to keep the Chinese down. If there were a rational defense based on objective verifiable facts, that would be great. What mainlanders take as an attack on their motherland is merely analysts and the press doing exactly what they do with other country. It is just that Chinese officials have no objective defense and so they take the easy way out and try to ascribe nefarious motives to the critic.

I am no economist and I have not followed the Chinese economy as closely as some of you have, however I don’t think the Chinese authorities have been lying to us all these years about China’s economic growth. “Surpresses info, denies reality, intimidates people from asking the right questions”? If that were the case they would have kicked people like Chovenec and Pettis out of the country a long time ago, wouldn’t they? I don’t know what qualifies as “objective criticism”, and I am sure most of the criticism is well founded, but that is not my point here. My main beef with western commentators and the western media in general is that they are painting a distorted picture by focusing on only the negative stuff. In the case of China, there is simply no middle ground; in western narratives China is either portrayed as a menacing superpower trying to take over the whole world, pandering to the anxiety, paranoia and the growing anti-Chinese sentiment in the west; or it is painted as a hell hole where nothing ever goes right.

Against this backdrop, “objective criticism” is all but lost: When you constantly have a bunch of laowais or foreign residents of China offering their earnest criticism on a 24/7/365 basis, people get tired of it and the message is lost.

You are not talking your book, but you could be seen as hedging your book. If things go well, everything’s great, like your careers, RMB holdings, etc. If things don’t go well, you become a more popular strategist, and claim a one up over others who were merely riding the bull. I mean this in a light-hearted way as I’m neither from China, nor from the West, so I’m only an interested observer. The problem with being bearish is that its a hard job and even if you are right, it takes a long time to prove and it becomes pointless by then. And, people don’t appreciate your being right on a bearish position – it seems unnatural to them, it goes against some innate sense of optimism, much more so in eastern cultures. Just look at Michael Burry and all that he had to go through and for how long. Don’t expect to go on victory laps and earn the respect of your peers or your personal relations – they will just look at you weird and move on to a more mundane but sunny topic.

In a book I wrote in 1999, I said: “We’re in the middle of an Internet bubble, and it’s all going to blow up, and it’s all going to come to a bad end.” After a dinner talk I gave, I was taken aside by a Merrill Lynch broker, and he said: “Look, you may well be right, but nobody became rich in America being a pessimist.” And he was dead right. The Internet bubble did blow up, and some people lost their shirts, but the overall process of economic growth and increased prosperity stayed in place. People will redouble their efforts to be more innovative and efficient…

I encourage you to continue to elucidate the economic difficulties facing China. It is never too late and it appears that the elites in China are to some degree more prone to listen than are commentators elsewhere.

I am Irish but live abroad. When at home in the first half of the 2000-2010 decade I spent a great deal of time trying to convince everyone I talked to that something unhealthy was going on and that it would end badly. It did. In a country of 4.4 million people there were 200,000-300,000 housing units surplus to requirements. Loans for land purchase to property developers turned bad and may finally represent 50-70% of Irish GDP. Five years on, house prices are down 50% from the peak and still falling. Some 80,000 mortgages where the holders live in the property are 3 months or more in arrears. The figure for mortgages on buy-to-let properties is not included. The current prices are at their 2000 level so there are 7 years of buying on mortgages in or close to negative equity. Near the end the lenders were extending loans at 105% of the purchase price and allowing multiples of 6,7 or 8 times the salary of the borrower.

This is a lot to chew on. However although the problems were building for a long time a lot of the damage was done in the last 18 months before the sudden stillness that preceded the storm. If a halt had been called in 2005 the volume of the deficits would have been considerably smaller. This is the dilemma of the last man trying to hold down the hot air balloon with a rope, the longer he holds on the more grave the consequences of letting go.

Much of the detail above became apparent to all after the fact. I have become interested in how much of this was knowable beforehand and indeed was being pointed out by a very small number of people in the press. But their message was extremely difficult to discern amid the cacophony from a wide range boosters. As you might expect economists at banks and estate agents, politicians, builders and developers were giving the Irish growth miracle their own shading which is to be expected and understandable. But the people who rejected words of caution most vehemently were normal citizens. I am a physicist with an interest in many things including economics but I have no training in the subject. If I only had a euro for every time a fellow countryman pointed this out to me, I would still be ignorant, but quite rich.

I became interested in China because I visited several times in the latter half of the last decade and I find it a fascinating place. My interest initially was general and because of my experience of Ireland above I began to wonder if such an outcome was possible also in China. Besides the obvious scale and speed of the expansion and some anecdotal hints I picked up while there one of things that sparked my curiosity most was the universal certainty of everyone who had an opinion was that China had it licked in every way.

It was my search for countervailing opinions that led me to barely a handful of bloggers that include you Patrick, Michael Pettis, Mike Shedlock and Alsosprach. But these were really quite hard to find.

So Patrick, please continue to point out the problems. It is sad that we live in times where there is pressure to preface anything we say or write in public with disclaimers and to pepper the content with caveats. We live in Lawyerland.

Don’t worry I think Stephen Roach was referring to Jim Chanos who is unashamedly talking his own book. Nevertheless Mr. Chanos make much more incisive observations of particular weaknesses in the Chinese economy with data backup whereas all one gets form Mr.Roach is “trust me I’ve been there”.

Those who suggest Patrick is at risk of talking his own book have simply become a victim of that other well known “western” phrase ‘they can’t see the woods for the trees’ … listen up princesses, its called independent journalism, free-thinking, free thought … the sort of stuff which goes on in Free World economies. Listen to what he’s trying to tell the One Party State, its by listening to someone as well-rounded and educated as he that the economy may just pull out of the gradual nose dive its in and produce a more balanced recovery. Right now Fixed Asset Investment is too high and Consumer spending too low for a soft landing to occur in the medium term.

Just a shame that you felt obliged to lay your personal history out in the public view. But entirely understandable, as it is unfortunately too easy in this country to simply hit the messenger. Especially if the messenger is a lao wai.

On the contrary, I think people in this country are much harsher towards their own than laowais. Some people simply attach too much importance to what laowais say, regardless of their message. Very unfortunate.

Patrick, leadership is often defined as being consistent and predictable – sometimes boorishly..The leadership in China is long term while being consistent and predictable. We lack this type of leadership in the West because of the short term of most of the political offices – five years max. Most major corporations do not plan for greater than five years so why do you expect that China will not do well in the long term? The economic path China is on was started over forty years ago. Secondly, it is always more challenging to governor or run a company during growth times. Demands out strips the resources available.

Dear Prof. thinks that it’s not wise to be long China considering what he actually writes.

I do not understand why you still own the apartment and have assets in RMB if this is how you perceive the economy to be?

There is a complete contradiction here.

You can easily sell the apartment and rent. Then convert some of the money to foreign currency every year, and the rest invest in wiser assets.

As no doubt both you and your wife pay taxes on your salaries, you can easily convert your salaries to foreign currencies and remit them outside of China.

Yet, you have chosen not to do so in complete contrast to what you yourself write.

Does not make any sense to me. Why not put your money where your words of wisdom are?

Disclaimer: I love China, I love Chinese people, I hope my wife would dump me so I can marry a Chinese girl they sure are much cuter,I love Jet Lee, I love whats-her-name from that Chinese movie, I love Chinese food, Go China Go!!!

I like the apartment we own in Beijing, it has value to us beyond its “market value” at any given moment. I also like my job — this is certainly an interesting place to be. Do you really manage your life like a portfolio, and measure it purely on a pecuniary basis?

you don’t manage your life like a portfolio, but you should manage your portfolio like a portfolio. I live in Canada and I feel increasingly uncomfortable with all my assets in Canadian dollar, given the housing market, rising debt and weak competitiveness. I’ve been moving money to the RMB and the US dollar and plan to do a lot more in the coming years. There is nothing wrong with moving you rmoney back to the US dollar

(unfortunately I just found out I get 0.05% interest rate on US dollar deposits. I am getting 3% in RMB deposits).

85% (Pew, Edelman) to 95% (Harvard) see China completely differently from you. And why not? They are recovering from the invasions, outgrowing the rest of the world, have an honest, competent government, have lifted 600 million people out of poverty, wages are rising 10%–17% annually, life is gooood.

As I commented below, I think that Pew survey isn’t worth the paper it’s printed on. There’s no reason to expect Chinese to be massively more satisfied than the rest of the world, especially when #2 rated Egypt has fewer people emigrating abroad than China.

Honest and competent government? I have never heard a Chinese describe the government as being honest. The Corruption Perceptions Index ranks as being very corrupt, so again I’m stumped at where your idyllic impressions are coming from.

“There’s no reason to expect Chinese to be massively more satisfied than the rest of the world”.
Kidding, right? Have you been following China’s trajectory for the past 35 years:
Wages rising 10–15% a year.
Poverty dropping like a stone.
Leading-edge infrastructure.
Space exploration.
Strong defense.
The Olympics.
Peace.
Prosperity.
Democracy for the first time in 3,000 years.
98% literacy for the first time in China’s history,
90% home ownership.
Less food insecurity than the USA.
National savings the envy of the world
And–obviously–”a neutral government shaping national consensus”.

Pew is not the only source of those stats. You can talk to the people who did the surveys there, and at Edelman, and at Harvard. Express your doubts. Check their methodology.

Good post. I can relate to what you said about Americans saying negative things about China. It always becomes an emotional battle, based on “jealousy”. As a foreigner here, if you’re very complimentary about China, no one asks any questions. If you say anything negative, even if its true, and even if you qualify it with something like “The US also has similar problems,” its because you hate China, or want China to fail. I guess it would be funny if the opinion wasn’t so pervasive. I also think this relates to the Chinese victim complex. Why are all these countries shooting OUR fisherman and arguing about OUR islands? It’s the world vs China, since 1949.

One particularly interesting point I see among my Chinese friends is their concept of money and how much of it the government has. If I discuss something about bad loans or wasteful investments, the usual response is “well, the government has enough money to cover all that anyway.” It’s a very different view from Western countries, where government funding is clearly limited, and most people realize this. It’s also scary when you think about this on a larger scale. ZTE, Huawei, Haier…I would argue that their top leadership at these companies would expect (or demand) government bailouts if things went south. Simply based on the commonly held notion that the government is a never-ending fountain of money.

Oh, Godfree, I get China. I understand how the CCP screwed things up royally throughout the 1950s and 60s, starving millions of people. The reality is the laobaixing still have dreadfully difficult lives. One billion scrape by so that 300 million connected ones can shop at Fendi and LV.
The article you cite is correct in that the economy is just one of the Qi pieces. Just as the citizenry are, as a whole, a playing piece, to be sacraficed as needed. Recall Mao’s quote during the famine of the Great Leap forward. “Better for half the people to starve while the other half gets their fill.”

85% – 95% of Chinese disagree with you, according to Pew, Edelman, and Harvard’s Kennedy School of Government. That’s how many ‘trust and approve of’ the Government of China. Who am I to argue with such overwhelming support?

Trust and approve of? Are you kidding me? Go talk to China’s neighbors. Aside from North Korea, that fine example of
Marxist Communism and a basket case of an economy, no one else trusts them. Go talk to the generations that know something about Tiananmen or Chen GuangCheng or any of the other things that China’s trustworthy government has lied about. Go to the streets and talk to the people. Ride a taxi. Talk to the cabbies. Talk to the people that plead with anyone going across the border to bring back baby formula and vitamins.

Don’t you think it’s peculiar that in the Pew survey so many people love to cite, Egypt is the second rated country for “satisfied with the way the country is going” at about 60%? The other countries drop of sequentially, 59%, 54%, and so on. But a 25% gap between country #1 and country #2, that doesn’t strike you as odd? It’s the same every year.

I am an American who wishes that all nations would prosper and be at peace with one another, but the above article about China is true, and you are going to see an eventual meltdown of the Chinese economy, especially if the U.S. economy tanks. There is another economic giant in the world that is going to collapse, but “his deadly wound will be healed.” For more info, go to http://www.churchofgodcolumbiana.com/ and learn what the future holds for the U.S., Europe, and China.

The Chinese currently hold a large part of our debt, and one of the main reasons why they are doing this is that by helping to keep us afloat they can then sell billions of dollars worth of their products to us. If our economy should tank(and it will), and millions lose their jobs, it would have devastating effects on the Chinese exporting economy, thus causing a downturn over there, and not only there but the rest of the world would suffer as well. Remember, we now live in a global economy.

You don’t have to be apologitic for your bearish views about China’s future. It’s business. Nothing’s personal.

Heard of Gordon Chang? The guy who has repeatedly been making calls of inevitable, imminent collapse of China? He is my hero. I think he is much braver and much more brilliant than you. This is why I call him a hero. Just on Jan. 1st of this year, he made another call from Foreign Affairs. He predicted China is to collapse at the end of 2012. (I felt much relieved, much secured after reading his article as I felt I won’t have to wait another decade to witness the death of China. I am thrilled as we are nearing the end of 2012!!!) I figure this time he might make it. If not, I am sure he will have the same article published by Bloomberg, or Fox Tv, or somebody else!

You should keep your spirit up. I understand what kind difficulties you have to go through after making endless wrong calls. But you just have to stick to your own instincts, your own principles and your own faith!

Heheh. First, if you read this an apology then you really missed the point. Second, if you look back over the past four years worth of posts on this blog, you’ll find that the “calls” I made (regarding bad debt, inflation, property market, etc.) had a pretty good track record of coming true.

What you really need is to take a hard look at the slowdowns in China and in India and do a good analysis. You need look what are the similarities and what are the uniquenesses of each economy, what are essencial and what are superficial, and understand why all these similarities and differencies are there and make an educated call at which economy will fare better in current economic situation, and give convincing explanations.

Of course it is just another joke that the Chinese economy will collapse at the end of 2012, if you look at how active the Chinese are in Aferica and in Southern America. If they are really in big trouble economically, they will retreat first. But what I see is they are advancing in almost all directions, except by-passing Europe and North America. And I have to admit they plan well and excute well.

Anyway, I believe Gordon Chang will have his article re-published somewhere FOR-EVER, pretty much like what you will do. It’s a political passion, a faith and a belief, but not a solid economic analysis.

Your good track record is no better than my guess. I guess China’s economy will grow less than 8% per year in the next 10 years. But what sense can my prediction make? None! It’s something everyone already knows, something they said they are going to do, and something we know economically sustainable.

The Chinese economy is huge. It may even be much larger than we know. For such big an economy, it is easy for one to find something unusal. But, what is the big picture? Do you have the ability and know-hows to get it? I don’t think any political precher has.

Gordon Chang did predict the timing wrongly,his mistake was not so much bad reading of Chinese economy,it was due to the fact that he under-estimated the ability of a communist regime to operate the under the capitalist system with the suppression of information and lack of transparency .This is not to say that the Western capitalists do not suppress information and are completely transparent,but they do it at a much higher level which are now starting to get exposed.and which Goron Chang may not even know by now.

Western people and Chinese people are all the same. They (we) will go to any length to postpone the inevitable. Reason enough to never try and time events. It’s like what’s going on now in Europe, it’s already over from day one, but who knows for how long the can kicking will last? Maybe one day more? Maybe one decade more (they’ll find a way…)?

According to the wealthy and well-connected owner of the firm for which I work, a friend of his in the insurance business has told him that wealthy Chinese are now using every trick in the insurance book to get money out of China, to an astonishing degree.

1. Wealthy individuals in all countries, who have a bit of sense, tend to diversify and have some assets in countries other than which they live in. It’s understandable and expected.

2. How many wealthy in China actually paid taxes in full on all their income? How many got their fortune in a fully correct way? My guess is that not too many. So, it’s also understandable that they are fearing that knock on the door to reclaim some of their ill gotten wealth. That and what seems to be stricter regulation, leaving less ways to abuse.